Do You Pay Tax when You Sell Inherited Property?
From the description above, it’s clear the family had a plan for their land. However, from the question posed in a recent article titled “I inherited land that recently sold. What will I owe in taxes?” from The Washington Post, it’s clear the plan ended with the sale of the property.
For an heir who is expecting to receive a share of the proceeds, as directed in the mother’s last will, the question of taxes is a good one. What value of the land is used to determine the heir’s tax liability?
The good news when it comes to paying income tax when you sell inherited property: when the great grandfather died, the land passed to the mother and her siblings. To keep this example simple, let’s assume the great-grandfather’s estate was well under the federal estate tax limits of his time and there were no federal estate taxes due.
Next, the mother and her siblings inherit the land. When a person inherits an asset, they usually inherit both the asset and the step-up in the value of the asset at the time of the person’s death. If the great-grandfather bought the land for $10,000 and when he died the land was worth $100,000, the mother and her siblings inherited it at that value. In other words, their “tax basis” is now $100,000 (not $10,000).
When the uncles sold the land after the death of their sister, the mother, her heirs inherited her interest in the land. If the person asking about taxes is an only child and an only heir, then he should receive his mother’s one-third share of the land or one-third share in the proceeds. With the stepped-up basis rules, the son inherits the land at its value at the time of the mother’s death.
Assuming the land was worth $300,000 at the time of her death, the son’s share of the land would be worth $100,000. That’s his cost or basis in the land. If he sold the land around the time she died or up to a year after her death, receiving his share of $100,000, he would not have to pay any federal income tax when he sells the inherited property.
If the family sold the land for $390,000 recently, the son’s basis in the land is $100,000 and his sales proceeds would be $130,000, or a $30,000 profit. He would be responsible for paying taxes on the $30,000.
So the answer to the question will depend greatly on whether the inherited property appreciated since the death of the loved one. The longer the period of time that elapses, the greater the chance that there will be an increase in fair market value, thereby increasing the taxable gain.
There will also be state taxes due on the profit and there’s an additional 3.8 percent tax on the sale of investment property. If the son used the home on the land as a primary residence, there would not be an investment property sales tax.
In this kind of situation where there are multiple heirs, it’s best to consult with an estate planning attorney to ensure that you will not have to pay income tax when you sell inherited property and to make sure that the transaction and taxes are handled correctly.
Another article that discusses taxable gain and tax basis include Taxes Due When Children Inherit A Home and Will Children Pay Taxes on Gift of A Home? and this one on estate planning for a business: You Need a Buy-Sell Agreement for Your Business
Reference: The Washington Post (July 26, 2021) “I inherited land that recently sold. What will I owe in taxes?”